While states' finances have stabilized, local governments still face rising employee costs that will compel both higher taxes and fewer services.

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Recent announcements of state budget surpluses have led to the popping of corks across the deepest-blue parts of America, particularly here in California. In some cases, the purported fiscal recovery has been enshrined by an emerging hagiography about Jerry Brown's steadfastness in the face of budget debacles. One prominent piece even argued that the “smart, bold progressive movement” actually “saved” the Golden State, in part, by forcing up income tax rates.

Yet, as Walter Russell Mead, among others, has argued, the states' fiscal meltdown has not been averted, but simply delayed, by the current asset-driven economic recovery. Taken together, the states owe $1 trillion in unfunded pension obligations alone. These costs are eating up much of the projected surpluses, even in prosperous and relatively frugal states such as Texas.

But the first place where the fiscal blowout will hit the road may be at the local level. This is, in part, because one way that states try to improve their balance sheets is by cutting aid to localities while imposing new mandates dealing with everything from housing to green policies. This has occurred in such places as Pennsylvania, Massachusetts, New Jersey and New York.

“Quietly and without fanfare, governors and state legislators approved overly generous pension packages, let stand costly, antiquated laws and continued to shift costs from Albany to our front doors,” noted one upstate New York newspaper.

So, even as state budgets improve somewhat, municipal budgets remain very vulnerable to cutbacks. Pew reports that both state aid and property-tax collections have continued to drop, something that perhaps will be slowed by a developing bubble in real estate values.

Similarly, according to a report by the National League of Cities, city financers at the end of 2012 projected a sixth consecutive year of year-over-year declining revenue. The ability of localities – particularly the most-distressed – to endure this pattern much longer is somewhat dubious.

In fact, the run up to a wave of municipal bankruptcies has begun. Seven major municipalities have already filed for bankruptcy, the largest being the city of San Bernardino. To a large extent, these bankruptcies are being driven by unfunded obligations for employee pensions. A new study by the Brookings Institute “estimated that the aggregate unfunded liabilities of locally administered pension plans top $574 billion. … On average, pensions consume nearly 20 percent of municipal budgets.” But the worst is yet to come. “[I]f trends continue, over half of every dollar in tax revenue would go to pensions, and, by some estimates, in some cases, would suck up 75 percent of all tax revenue.”

This has locked many localities across the country into a classic vicious cycle as they try to dig their way back to growth. Unless radically reformed, health care and retirement obligations to employees seem certain to outweigh the ability to fund necessary government functions, the very things – infrastructure, public safety and other economic development components – necessary to nurse a region and its governments back to health.

By far, most vulnerable will be those cities with high unemployment, rising crime and tepid recoveries. These will include many of America's most violent cities – Detroit, Cleveland, St. Louis, Chicago, Memphis, Tenn., – as well as those with generally dysfunctional schools and decaying infrastructure. The idea of cutting police services in such places would invite even greater deterioration of public order.

This process of small-scale deterioration is already well advanced in California. When it comes to buck-passing to the local level, no one can outdo the Golden State. Gov. Brown's “realignment” strategy put the responsibility for state justice programs largely on local governments (though this came with promises of increased state aid). Brown also oversaw the dissolution of the state's 400-plus redevelopment agencies, some of which may now be forced into bankruptcy. Many cities consider these agencies, which provide tax relief to businesses, as one of their most effective economic development tools. So, while state debt is expected to decline by $1.7 billion next year, local-government debt in California is actually set to increase by $600 million.

Many counties and localities risk also losing their health care benefits under Gov. Brown's revised fiscal year 2013-14 budget. These changes will be hardest on those localities with the biggest problems, notably some smaller cities already tilting on the edge of bankruptcy. As many as 10 others, including Oakland and San Jose, could join them. Many others are simply cutting back; Sacramento is now asking newly recruited police officers to pay into their pension plans before joining the force.

These problems also are deeply entrenched in the state's largest city. Los Angeles, more than any of the top 10 cities in the country, with the possible exception of Chicago, still suffers from quasirecessionary conditions. Not surprisingly, L.A.'s budget situation, in large part due to pension and other employee-related costs, remains perilous. A former mayor, businessman Richard Riordan, has predicted that, unless pensions and compensation are reformed dramatically, the city will eventually slide, inexorably, toward bankruptcy.

The primary culprit in this slide, notes Riordan, has been the political domination of Los Angeles, and other cities, by public employee unions and the lack of true political competition. The original poster child for this is San Bernardino, where labor costs consumed 80 percent of the city budget, in large part due to public-sector unions' investment in local political races.

Bigger and somewhat economically stronger, Los Angeles may not soon go the way of San Bernardino, but its fiscal problems remain severe, with a projected $800 million deficit over the next four years and pensions that are underfunded by at least $15 billion. Clearly, these shortfalls will continue to undermine the city's ability to keep its streets safe, roads paved and parks operating – until City Hall is willing to stand up to the public-sector lobby.

The most recent citywide election was not too comforting in this regard, since both candidates for mayor were reliable allies of city worker unions. But, at least, it should be noted that the loser, Wendy Greuel, was, in part, defeated by revelations of her massive financial backing from those unions. It almost certainly hurt her standing with what should have been her base among more conservative, quasisuburban voters from her “hood” – the San Fernando Valley.

Yet, even if incoming mayor Eric Garcetti can right the ship, residents of Los Angeles are likely to face a combination of rising taxes and fees for years to come to address soaring pension costs. Given the financial drag of pension and other employee benefit obligations, even traditional city services, such as street repair, will likely need to be funded by additional debt or fees on property owners.

Short of major reform, this self-defeating pattern of higher local taxes and fewer local services is likely to continue even if state economies and budgets climb out of their recent distress. Yet, at the same time, this presents an opportunity to rebalance the relationship between private- and public-sector interests.

If good habits are learned first in the home, perhaps the road to fiscal health will have to begin at the local level. Sacramento and other state capitals have demonstrated skill at kicking the can down the road while shirking their responsibilities to local governments. Instead, it may fall upon the localities to come up with ways to overcome decades of poisonously irresponsible decision making and concoct the proper fiscal antidote.

Register opinion columnist Joel Kotkin is a Distinguished Presidential Fellow in Urban Futures at Chapman University. He is the executive editor of www.newgeography.com.

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